The Federal Reserve will probably lower its benchmark interest rate in the first quarter of 2007 as slowing economic growth diminishes inflation pressures, according to economists at Citigroup Inc.
The biggest U.S. bank by assets previously forecast the Fed would keep its target rate for overnight loans between banks at 5.25 percent through June. The bank now predicts a quarter-point reduction by March, with the Fed holding the rate at 5 percent through September...
Citigroup also lowered its forecast for benchmark 10-year Treasury yields to an average of 4.6 percent in the first quarter, from 4.9 percent.
The motivation for this change of heart is no mystery:
"There's softer growth, and with oil prices down and lower inflation, the Fed in a sense can follow the market's lead,'' Michael Saunders, chief Western European economist at Citigroup in London, said in an interview today. "A modest ease in rates should cushion the economy.''...
"The U.S. economy currently is in the most intense phase of its downdraft, due to plunging housing construction,'' Citigroup Global Markets analysts, including Todd Elmer in New York, wrote in a report to clients yesterday. "The cooling in demand should reduce inflation risks sufficiently to open a window for a token easing early next year.''
Also at Bloomberg, Caroline Baum says things in the housing market are even worse than you think:
For months, builder sentiment looked out of sync with the actual housing statistics. When one considers that the worst news on new home sales may not be reflected in the government data, it's easier to understand why they're so glum.
Simply put, cancellations are rising, and they aren't being captured in the aggregate statistics because of the way the survey is designed. Hence, sales are being overstated and inventories understated.
"Once a sales contract is signed, there's no way of recording the cancellation or putting the home back in inventory,'' says Dave Seiders, chief economist at the National Association of Homebuilders in Washington. "Builders keep track of gross and net sales; we don't have a net sales number from Commerce.'' ...
The effect of higher cancellations is "to overstate the overall level of sales and understate the level of inventories,'' [Joe Carson, director of global economic research at AllianceBernstein] says. The opposite is true at the bottom of the economic cycle, when sales pick up and the resold homes aren't registered as a sale or removed from the "for sale'' pile.
How bad is it?
We know from big builders that cancellation rates are rising. Seiders says the rate "has roughly doubled over the last year'' and is ``more serious at the big companies.''
Just this week, Lennar Corp., the No. 3 U.S. homebuilder, said its cancellation rate was running at more than 30 percent. Net new orders fell 5 percent in the quarter ended Aug. 31.
Cancellation rates rose to 29 percent in the April-June quarter at D.R. Horton Inc., the second-largest homebuilder, and deteriorated further in July, according to the company. That compares with an historical average rate of 16-20 percent.
And earlier this month, KB Home said net orders (an order is considered a sale) plummeted 43 percent in the three months ended Aug. 31, a rate that includes cancellations.
I'm still not sure about the macroeconomic consequences of comparisons like this...
What makes the current situation so worrisome is the "unprecedented inventory overhang, encompassing new and existing markets and many of the largest metropolitan areas,'' Carson says. "Its sheer size raises the odds that prices will fall more and longer nationwide than they did in the 1990s.''
... as I am convinced that overall conditions in financial markets are very much different today. But I won't object to "worrisome."
UPDATE: Dean Baker weighs in on cancellations as well:
The [new home] sales figures are also somewhat exaggerated, since there are many more cancellations now than in the past. (Cancellations are never subtracted from sales.)